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Opportunities North Of Border Could Surprise Many

OCEAN CITY — With the U.S. recovery still sluggish, many investors have begun shifting their portfolios to tap more global sources of growth. Although emerging markets have rightly attracted attention in this environment, there may also be some surprising opportunities just north of the border.

Many Americans incorrectly think of Canada as more like an extension of the U.S. rather than a sovereign nation with its own unique economy. In fact, while 70% of Canada’s exports do indeed come to the U.S., its economy bounced back from the recession more quickly than that of its southern neighbor. Plus, with a rich supply of natural resources and a favorable policy environment, it may be ready for stronger growth than most other developed countries are — and could thus be a potential boon to investors looking for international diversification.

Consider, for example, that Canada is the U.S.’s major supplier of oil, surpassing even Saudi Arabia.

"Twenty percent of U.S. energy imports come from Canada," says Glen Hodgson, senior vice president and chief economist at the Conference Board of Canada, a nonprofit economic research organization. "Canada’s oil output is on a path to double over the next decade." Beyond crude oil and natural gas, resource-rich Canada has an abundance of wheat, timber, uranium, copper and other base metals, gold, and diamonds.

What’s more, "Canada was shielded from the economic effects of the downturn because its banking system largely escaped the problems in the U.S. and Europe," says Sheryl King, head of Canada economics and strategy at BofA Merrill Lynch Global Research. The housing bubble that hit Americans hard was nonexistent in Canada, although home prices have experienced double-digit percentage gains in the past two years, according to King.

The result? After three quarters of contraction, Canada’s economy started growing again in late 2009. BofA Merrill Lynch Global Research economists are forecasting annual growth of 3.1% this year, compared with 2.5% for the U.S.

Perhaps more important, Canada doesn’t seem to be as burdened by some of the factors that are weighing down the U.S. economy. All 420,000 of the Canadian jobs lost to the recession have been regained. Whereas the U.S. economy is operating under a $1.3 trillion deficit and a 70% debt-to-GDP ratio, "the Canadian federal government is reducing its debt-to-GDP ratio from a peak of 35%, and provincial governments are on plan to balance their budgets over the medium-term, some earlier than others," Hodgson says. Canada’s equity markets have also rebounded. "On a total-return basis, Canada was the first developed country to surpass its 2008 stock market peak," King observes.

So which sectors of Canada’s economy are poised to grow? Noting that "this government will likely be more receptive to foreign ownership of Canadian firms," King expects takeover bids — particularly for companies in the resources sector — to drive up the value of specific stocks.

In addition to commodities, sectors likely to generate growth include technology, industrials, autos and energy. And although Canada’s forestry companies have been significantly affected by the U.S. slowdown in home construction, many have been transitioning to new product lines, such as biofuels and wood products used in pharmaceuticals. What’s more, Japan could spur increased demand for timber as it rebuilds communities destroyed by the tsunami, Hodgson says. In King’s view, Canada’s financial industry is very stable and has the potential to outperform foreign financials.

Canadian exporters also have considerable room to grow. "Our companies have been a little slow in taking advantage of the fundamental shift in the global economy with the economic rise of emerging markets, led by China, and in selling to those markets," Hodgson says.

In terms of fixed-rate investments, the Bank of Canada may raise interest rates later this year to keep inflation — currently running at 2.2% to 2.3% — in check. If that happens, the Canadian bond market will be vulnerable to a substantial sell-off as yields rise and prices fall.

Even so, investors might want to consider Canadian government and corporate bonds for the high quality of the underlying credit, King says. In addition to the safety of these bonds, American investors will realize a currency advantage if the Canadian dollar continues to appreciate against the greenback.

"The strong growth story that Canada has demonstrated during the past several years is still very much intact," King says. "Canada may benefit from the ever-increasing demand for commodities, and compared with other developed nations it has a big jump-start on economic recovery from the recession. Canada’s equity market is also unique in having completely rebounded, and I’m optimistic that a new government will encourage foreign investment, which will benefit Canadian companies. All in all, it’s a great time to invest here."

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)